U.S. firms spend less time communicating with investors about social and environmental issues than their global peers. They also disclose less. U.S. investors, in turn, incorporate social and environmental factors into their strategies at a level below the global average, and have less influence over responsible business behavior than do investors in many other countries. This aversion to transparency regarding social and environmental impacts isn’t surprising, as it stems from the treatment of the concept of “materiality” within U.S. securities law.

In November 2018, the Sustainability Accounting Standards Board (SASB) published voluntary ESG (environmental, social, governance) reporting standards that align precisely with the way U.S. law defines materiality. In so doing, the SASB standards have ushered in a new era in corporate environmental and social transparency. SASB has enabled the filing of shareholder resolutions that, for the first time, can explicitly request disclosure according to standards that dovetail with U.S. securities law.

Materiality in U.S. Securities Law

According to U.S. law, whether corporate disclosure is transparent or fraudulent is determined by Rule 10b-5 of the Securities and Exchange Act. The rule prohibits publicly listed companies in the U.S. from making “material” misrepresentations — in other words, they cannot falsify information in their financial statements. In addition, while firms are not generally required to report on their unethical practices, they must include these practices in their disclosures if their omission makes the filings “materially” misleading.

“Materiality” is a controversial concept. The Supreme Court grappled with the definition of materiality in 1976 and again in 1988, and determined that, for the purposes of disclosure requirements relevant to the trading of securities, materiality should be defined through the lens of what is important to only one specific group of stakeholders: investors. As a result, materiality refers to what investors would consider important enough to affect their decision to buy, sell, or hold a stock or bond, or to influence how they would vote their shares at the company’s annual general meeting. This is known as “financial materiality.”

The Securities and Exchange Commission (SEC), tasked with enforcing Rule 10b-5, has always considered specific social and environmental business impacts to be financially material, but not to such a degree that it has required robust reporting on the subject. Until the SEC does, business is free to avoid disclosure of “immaterial” social and environmental impacts.

The question of whether a disclosure would be financially material is significant. The SEC won’t undertake enforcement actions concerning disclosure that it doesn’t see as financially material. Securities fraud class actions won’t survive a motion to dismiss if a misrepresentation can’t be shown to be financially material. And institutional investors who are fiduciaries won’t support shareholder resolutions or engage with management on topics they don’t consider financially material (there is disagreement within the investment community about the materiality of specific ESG issues). Since existing sustainability reporting standards, such as those published by the Global Reporting Initiative, do not purport to have any relationship to financial materiality, they are excludable from audited financials, are non-comparable across companies, and are without significance for U.S. law regulating securities trading.

Along Comes SASB

Into this breach has stepped the Sustainability Accounting Standards Board (SASB). From its formation in 2011 until the publication of its compendium last November, SASB has had one mission: crafting and compiling sustainability standards that explicitly target financial materiality, based on the Supreme Court’s definition. The standards are tailored to each of 79 industries in 11 sectors. They encourage companies to disclose information on a variety of topics, including greenhouse gas emissions, water usage, engagement with neighboring communities, security and human rights impacts, indigenous rights, and labor relations.

To garner support for these standards and ensure that they reflect industry understandings of materiality, SASB created working groups of company representatives, industry experts, and investors. They tied each standard to financial performance, and required overwhelming consensus for it to survive to publication.

SASB standards are voluntary, but there is reason to believe that they will constitute an effective disclosure regime because they are supported by investors, including some of the world’s largest. Asset management behemoths like BlackRock, Vanguard, and State Street have not only embraced, but also helped to create the SASB standards. All three investment advisers, as well as other sizable asset managers such as Capital Group, Nuveen/TIAA, and the investment management divisions of Goldman Sachs, Morgan Stanley, and Bank of America Merrill Lynch, are all members of the SASB Investor Advisory Group (IAG).

As SASB notes on the IAG web page,

Investors can play an important role in enhancing disclosure effectiveness by expecting companies to disclose performance on material ESG factors… The IAG comprises leading asset owners and asset managers who are committed to improving the quality and comparability of sustainability-related disclosure to investors.

IAG members subscribe to various statements disclosed on its web page, involving participating in ongoing standards development, encouraging companies to disclose material ESG information, and believing that SASB’s approach, “which is industry-specific and materiality-focused,” will help provide investors with “decision-useful” information.

As a group, the SASB IAG collectively manages for their clients between 20 and 25 percent of the U.S. stock market by my estimation. That is a powerful degree of influence. With this group pressing for transparency in sustainability disclosure, even a voluntary regime acquires teeth.

An Early Test

On November 16, nine days after SASB published its standards, the non-profit shareholder advocacy group As You Sow filed a shareholder resolution requesting disclosure against one of them. The resolution was filed with PACCAR, Inc., a major North American truck manufacturer. It requested that “the Board of Directors issue a report on sustainability… prepared in consideration of the SASB Industrial Machinery and Goods standard, describing the company’s policies, performance, and improvement targets related to material sustainability risks and opportunities.” Until then, PACCAR had never published a stand-alone sustainability report.

The resolution’s supporting statement requested compliance with the SASB industry standards on “Energy Management; Employee Health & Safety; Fuel Economy & Emissions in Use-phase; Materials Sourcing; and Remanufacturing Design & Services.” Highlighting Materials Sourcing, it further specified that “our company does not disclose how it manages critical materials sourcing risks.”

When a resolution is filed, the target corporation’s typical first reaction is to try to exclude it from its annual general shareholders’ meeting ballot, even if there is little expectation of it passing. If the exclusion effort is unsuccessful, the resolution must be published in the announcement of the annual meeting, the so-called proxy statement, with allegations of sub-standard corporate behavior on display for all to see. A series of criteria by which a company can exclude a shareholder resolution is outlined by SEC Rule 14a-8. A company will normally petition the SEC to ask it to take no punitive action if it excludes a resolution under one or more of the criteria; these petitions are called “no-action” requests.

In December 2018, PACCAR published their first-ever sustainability report. Later that month, the company filed a no-action request based on the criterion of “substantial implementation.” In other words, there was no point in voting on the resolution because the company had issued a SASB-compliant report.

A perusal of the sustainability report leaves the impression that it was put together in slap-dash fashion, drawn from the company’s existing disclosure to various governmental and non-governmental sources. For example:

  • The SASB Energy Management standard requests data that should already appear in any company’s CDP (formerly Carbon Disclosure Project) Report. While the PACCAR sustainability report doesn’t specifically address the Energy Management standard, the no-action letter pointed to its CDP language as compliant disclosure.
  • The SASB Employee Health & Safety standard requests information on any workplace injuries/illnesses and fatalities as well as “near misses” that merit investigation, according to OSHA. The PACCAR sustainability report includes the two statistics that they already report to OSHA, but not the recommended, though apparently unreported, “near miss” rate.
  • The SASB Fuel Economy & Emissions in Use-phase standard requests a series of metrics related to sales-weighted truck-fleet fuel efficiency, along with sales-weighted emissions of various pollutants, among the vehicles that PACCAR produces. The sustainability report makes no mention of these, and the no-action letter refers again to the company’s CDP disclosures. But while the CDP disclosures do provide metrics on emissions in use-phase, they aren’t the metrics that SASB requests.
  • While the SASB Remanufacturing Design & Services standard asks for disclosure of the amount of revenue attributable to remanufacturing, the sustainability report merely mentions remanufacturing revenue of some undetermined amount. PACCAR apparently doesn’t track this figure.

Clearly, the company pled “substantial implementation” by hammering its existing square reporting pegs into round SASB holes. But there is one SASB standard for which the company actually produced new and compliant disclosure in its sustainability report. This was the SASB Materials Sourcing standard, the standard most emphasized in the supporting statement of the shareholder resolution.

Did PACCAR comply with the resolution out of fear that its Investor Advisory Group shareholders would honor their commitments to SASB? We’ll never know. All we know is that a victory for transparency, albeit a small one, has been achieved. And that’s a proof of concept for how SASB’s new sustainability standards, premised on financial materiality, can promote better sustainability reporting by publicly listed companies.

 

Photo by Matthew Henry on Unsplash